Reform - All posts tagged Reform

A People’s Liberation Army soldier near the border of China and Russia.

Capital Economics says “fears of a widespread crisis in the emerging world are overdone” and offers ten key issues that will shape emerging market investing in 2015:

Expect selected crises rather than widespread crisis: Russia and others will be hurt by lower oil prices. The rise in the dollar will pressure Turkey and other countries with high external debts.

Growth of 4.5% is the new normal with structural problems in the BRIC economies stifling growth from the 6% rate one expected before the global financial crisis.

Deflation will be temporary, mostly in Europe and Asia, due to lower oil prices. It’s more of a concern in developed markets.

Rising U.S. interest rates: emerging market equities have performed well in each of the past two U.S. tightening cycles, and Capital Economics expect EMs to perform relatively well next year too. “The big and necessary adjustments in many EM currencies have already taken place.”

The Russian economy is likely to produce marginal growth of 0.2% this year, and a 0.5% decline in real output in 2015, given mounting challenges.

So says Gregor Eder, an economist at Allianz, in a report today on the forecast for the Russian economy. He notes that the ruble has plummeted 30% this year against the dollar. Consumer prices rose more than 8% in October. Gross fixed investment could tumble 5% this year. U.S. and European Union sanctions against Russia, following its annexation of Crimea, contributed to an almost $53 billion decline in Russia’s foreign debt compared with the previous quarter.

He concludes “it will take some time before optimism in the business sector has firmed up sufficiently for companies to start investing again.” Eder writes:

“Essential now would be the implementation of a sweeping economic policy reform agenda in order to raise the medium and long-term growth potential of the Russian economy appreciably again. In our view a sustained improvement in the business climate is of pivotal importance. Urgent action is also needed in investment in human capital, the diversification of the Russian economy away from the oil and gas sector, reform of the pension system and of the fiscal policy framework. In our estimate, the willingness of Russian policymakers to enact radical reforms is currently on the limited side. Without an end to the conflict between Russia and Ukraine it is hard to picture an improvement in the Russian business climate. All told, we are not assuming that substantial parts of the reform agenda sketched out briefly above will be implemented in the near future. Over the medium to long term, this means that economic growth of significantly more than 2 to 2½% a year is highly unlikely. … The short-term outlook is overshadowed entirely by the economic repercussions of the Russia-Ukraine conflict. Particularly hard hit are private consumption and investment activity.”

Indeed, since a ceasefire was declared along the eastern border of Ukraine and Russia, an estimated 1,000 people have died in eastern Ukraine, the BBC reports. Russia’s Micex Index is down 4.5% year to date, and rose 2.6% in the most recent trading session. The Market Vectors Russia ETF (RSX), is up 1% today but has tumbled 27% this year.

Among more volatile trading vehicles, the Direxion Daily Russia Bear 3X Shares ETF (RUSS) is down 3.5% today, but is up 46% year to date. The Direxion Daily Russia Bull 3X SharesETF (RUSL) is up 3.5% today, but fell nearly 46% so far this year.

AT&T is positioning to be a stronger player in Mexico’s heavily-regulated telecom sector.

Over the weekend, AT&T said it will buy Mexico’s third-largest mobile carrier, Iusacell, from Grupo Salinas for $2.5 billion. Nomura writes that the transaction has risks: it will only happen once Grupo Salinas buys the half of Grupo Televisa (TV) that it does not own, likely in the first quarter of 2015. In addition, it’s unknown how much cash or stock will be used, nor the currency to be used.

Reuters reports:

“For AT&T’s to extend high-speed service across the border will require significant investment in Iusacell’s patchy network … in direct competition with former ally Carlos Slim‘s AmericaMovil, whose shares have fallen some 3 percent since news of the deal.”

“The deal suggests AT&T might be interested in becoming a strong player in Mexico. The purchase signals that AT&T could shop for the part of America Movil it has to sell in order to shed its status of ‘Preponderant Player’ imposed by [Mexico's] regulator. This transaction could be much larger ($13-17.5 billion), but again it is impossible to know if the inflow would be in dollars. In the case of America Movil, which has a strong presence in other countries, the probability that the deal is in MXN [pesos] is even smaller. … there is a possibility that the transaction affects USDMXN, although it is impossible to know for sure.”

Mexico’s President Enrique Pena Nieto is in China to talk trade, and observers expect awkward interactions.

China is Mexico’s second-largest trading partner. But last week, Mexico’s government cancelled a nearly $4 billion high-speed train contract won by a group headed by China Railway Construction (CWYCY and 1168.HK). The group included four Mexican partners, one of which has done government business and is tied to a large residence owned by Mexico’s first lady. The implication is that the consortium could have received preferential treatment.

China Rail has threatened legal action over the contract cancellation, according to Bloomberg. Teneo Intelligence writes:

“Pena Nieto revoked the contract amid concerns over transparency in the bidding process. The president’s back is already against the wall following the exposure of corruption and criminal penetration in local politics that led to the killing of 43 students in September. Pena Nieto urgently needs to reassure potential investors looking at Mexico’s oil opening that insecurity and corruption are under control.”

Mexico is opening its energy sector to competition, and the nation’s supreme court said last week that it would not hold a referendum on the revision of energy law that puts energy reform in motion. See recent posts on Mexico and energy on Barrons.com.

For long-term investors, the latest news out of South Africa’s divided labor movement points to the possibility of future political reform.

Eurasia Group’s Mark Y. Rosenberg sums up the latest:

On Nov. 7, “the National Union of Metalworkers South Africa (NUMSA)–the country’s largest union, which claims over 330,000 members–has been expelled from Cosatu, the trade union federation in a “governing alliance” with the ruling ANC [Party] (as well as the South African Communist Party, SACP).” The explusion was “ostensibly for organizing across sectors and poaching members from other affiliates (violating Cosatu’s “one union, one sector” policy), as well as its decision not to back the ANC in the May 2014 election. … The NUMSA rupture will also increase union rivalries and drive labor instability, especially in metalwork, mining, construction and transport … We also expect NUMSA’s expulsion will make upcoming public sector wage negotiations more difficult for the government, reinforcing our call that Treasury’s projection of a CPI wage increase probably will not hold …”

And Rosenberg explains what it means:

“In the longer-run … a divided labor movement is positive for much needed labor reform in South Africa. A smaller and weaker Cosatu will be less able to deliver votes and labor stability for the ANC, reducing its ability to block reforms to the country’s rigid, highly majoritarian labor laws and bargaining institutions. … With Cosatu worth less to the ANC politically, and given stubbornly high unemployment (officially 25%, over 50% among youths), the structural prospects for labor reform will improve. That said, significant reforms remain unlikely for at least the 2 years … the government is unlikely to take on a policy reform that threatens (remaining) labor support before the 2016 municipal elections. As such, our long-term (24 month) trajectory remains Negative.”

The iShares MSCI South Africa ETF (EZA) is up 0.34% today, and up 4.6% year to date, while the iShares MSCI Emerging Markets ETF (EEM) is down 0.44% today and is off by 1.5% this year. U.S.-traded shares of South African energy and chemicals company Sasol (SSL) are down 0.23% today, and are down 2% this year.

India has been the crown jewel of emerging market stock performance, with a 32% rise in its benchmark index this year.

But investors continue to bet on reform following the May election of Prime Minister Narendra Modi, and selloffs have been viewed as buying opportunities. The S&P BSE Sensex Index is up another 6% so far in November, and some largecaps have outpaced the index. ICICI Bank (IBN) is up 18% this month and Dr. Reddy’s Laboratories (RDY) is up more than 14%, while Tata Motors (TTM) is up nearly 9% .

Smallcap funds have done especially well this year, outpacing the Sensex Index: the iShares MSCI India Small Cap ETF (SMIN) is up 52% and the EGShares India Smallcap ETF (SCIN) is up 50%, according to FactSet data. Two funds that have underperformed the index: the EGShares Infrastructure ETF (INXX) and the PowerShares India Portfolio (PIN), up 28% and 27%, respectively, year to date.

So is there still upside with those double-digit returns?

The Wall Street Journal quotes Deena Mehta, managing director with Asit C. Mehta Investment Intermediates, who thinks the Sensex could rise another 50% in the next 18 to 24 months:

“Every correction is being bought in a big way,” Mehta says.

The counterpoint comes from Justin Leverenz, who manages the Oppenheimer Developing Markets fund (ODMAX). He said in the recent Barron’s emerging market roundtable that the election of one person, in India, Indonesia or Brazil, “fundamentally cannot change anything, but the markets get terribly excited.” He added, on India equities:

“There’s extreme enthusiasm about all things Modi. I think it’s misplaced. He may be able to break through some bottlenecks, but he is not going to change the constitution. Some of the highest-quality companies and extraordinary management teams are in India, but in the next three years, at these prices, you won’t make money.”

Argentina lawmakers voted in energy legislation that could help the country boost its oil and gas production over the next two decades.

It took months of negotiations between the government, provincial governors and other interests to agree on distributing revenue from the country’s oil and gas deposits. The legislation now requires the signature of President Cristina Fernandez de Kirchner.

Companies are lukewarm to the legislation, says Nicholas Watson at Teneo Intelligence, given Argentina’s economic malaise, currency controls and soaring inflation – 40% by some estimates. According to Bloomberg, the new parameters:

allow companies that invest $250 million over three years to sell 20 percent of production in international markets without paying export taxes.

create a federal auction system, replacing one that varies by province.

Watson writes:

“The most positive take-away from the reform is greater regulatory consistency. While provinces set their own royalties and terms for concessions, the new system establishes a country-wide 12% cap on royalties (rising to up to 18% on concession extensions), and introduces a national auction system. In addition, the reform eliminates the carried interest regime by which provincial oil and gas companies have held minority stakes in concessions without having to make up-front investments. And for companies, the new law extends license timeframes, lowers the bar at which point exemptions on export taxes take effect from $1 billion to $250 million, and loosens currency controls by permitting companies to retain hard currency earned from 20% of their exports.

Buenos Aires provincial governor Daniel Scioli’s chief economic advisor last week said that it would take four years to bring inflation down to single digits … devaluation expectations will cause companies to delay investments. Barring a deal with holdout creditors early next year and/or pragmatic moves to correct economic distortions, confidence is likely to remain muted until after Fernandez leaves office in December 2015.

So say Jefferies analysts, who reiterated a Buy rating on HDFC Bank (HDB and HDFCB.India) after it reported results. It’s their top pick in the sector; Jefferies’ revised price target of 1,060 rupees implies upside of roughly 18% for the stock, despite a lofty valuation. The U.S.-traded shares are flat today.

Jefferies analysts Nilanjan Karfa and Poornaa Venkatesan write:

“HDFCB reported 20% profit growth. … Net interest income grew at 23.1% year over year, in line with estimates. Non-interest income grew 11% driven by 13.4% growth in core fees. Fee income has picked up owing to increase in mutual fund distribution & liability driven fees. Operating expenses were a bit higher than expectation – up 19.2% year over year mainly due to increase in branches, staff cost and transaction related expenses. … Management indicated that over 50% of the employees hired are sales officers. This suggests the bank’s commitment to achieve customer growth and improve point of sale service. … Loan growth showed improvement, up 21.8% year over year. As per the bank’s internal classification, retail and wholesale loans grew at 17.3% and 21.8% respectively. As per RBI’s classification norms, retail loans grew at 9.8% year over year and wholesale at 35.7% year over year . Retail loan growth came in mainly from credit cards (+28.9% yoy), Kisan Gold card (+63.4% yoy), Housing loans (+19.5% yoy) and personal loans (+19.8 yoy).”

Jefferies expects compound annual growth in earnings per share of 23.7% in the fiscal period of 2014 to 2017, “driven by improvement in loan growth (27.1% CAGR) and stable NIMs (avg. 4.4%). The stock is expensive at at 3.4 times fiscal second quarter 2016 adjusted book value, and 19 times forward earnings, but Jefferies thinks shares can reach its price target based on a forward book multiple of 4.0x and 22.5x earnings.

The S&P BSE Sensex Index rose 0.8% in the most recent trading session, continuing a four-day winning streak that is the largest since early September. iShares India 50 ETF (INDY) is down 0.4% today, while the EGShares India Consumer ETF (INCO) is up 0.6%.

Foreign companies will not be allowed to conduct commercial coal mining in India, but some domestic energy consumers and producers rallied on the news, including steel producer Jindal Steel & Power (532286.India), which rose 7.5%, and natural resources producer Sesa Sterlite (SSLT and 500295.India), which is up nearly 4% in U.S. trading. They are among the companies able to participate in coal mining auctions, with an e-auction for private companies to be held in three to four months, according to Reuters.

Following the plummet in oil prices, the deregulation of diesel and the lowering of natural gas prices were arguably Prime Minister Narendra Modi’s “most significant reform since coming to power in May,” write Shilan Shah, India economist, and Gareth Leather, Asia economist, at Capital Economics. “The timing of the move is shrewd. Global oil prices have fallen by nearly 25% this year meaning that the effect on the prices consumers pay will be negligible. Mr Modi also wanted to wait until the weekend’s two important state elections were out of the way before pushing ahead with subsidy cuts, which in the past have proved controversial.”

“From an economic standpoint, subsidies create inefficiencies and are a burden on government finances. Diesel subsidies alone eat up around 8% of government revenue in India. By supporting demand for imported oil, subsidies can also put pressure on current account positions. This is particularly relevant to Indonesia, given that it continues to run a sizeable current account deficit, which in turn could make it vulnerable when the Fed starts to hike interest rates. Subsidy reform is also being seen as a test of the new leaders’ commitment to market friendly reforms …”

About Emerging Markets Daily

Emerging markets have been synonymous with growth, but the outlook for individual nations is constantly changing. Countries from Brazil and Russia to Turkey face challenges including infrastructure bottlenecks, credit issues and political shifts. Barrons.com’s Emerging Markets Daily blog analyzes news, data and research out of emerging markets beyond Asia to help readers navigate the investment landscape.

Barron’s veteran Dimitra DeFotis has been blogging about emerging market investing since traveling to India and Turkey. Based in New York, she previously wrote for Barron’s about U.S. equity investing, including cover stories and roundtables on energy themes. Dimitra was among the first digital journalists at the Chicago Tribune and started her career as a police reporter at the Daily Herald in the Chicago suburbs. Dimitra holds degrees from the University of Illinois and Columbia University, where she was a Knight-Bagehot Fellow in the business and journalism schools. She studies multiple languages and photography.